MARKET AND ALLOCATION
Our experts monthly overview
OUR CENTRAL SCENARIO
Deputy Chief Executive Officer,
Chief Investment Officer
The latest statements from the two main central banks have now provided us with clarity. While central banks continue to keep a close watch on inflation, they will not be raising their short-term rates in the foreseeable future and will now wait for inflation to converge towards their target. In the meantime, fixed-income markets continue to react to the surprising strength in US growth, as seen in the spike in the 10-year US yield before it pulled back on reassuring language from Fed chairman Jerome Powell on whether monetary tightening would remain in place. Against a backdrop of US growth that is likely to slow in the coming months and European growth that is hovering around 0%, short-term rates are likely to remain stable for the next three quarters before moving back down in the second half of 2024. Bond yields still look attractive, at the very least for the carry trade opportunities around their current levels, which are near our targets.
Moreover, amidst the prevailing geopolitical uncertainty, they offer good protection in the event of an escalation in the current conflicts.
We remain confident in corporate bonds, whose carry opportunities and rate components look attractive, but we prefer the highestrated segment of the curve to high yield, in light of the pending economic slowdown and refinancing needs. Selectivity will be essential in this context.
Equity markets remained volatile in the midst of the three main risks that they are vulnerable to: interest rates, the geopolitical context and the likely downgrades in earnings forecasts for 2024. While the first of these now looks like less of a threat, revisions to guidance and earnings forecasts could still weigh on share prices. Moreover, beyond the human tragedy involved, the risks of an escalation of the Middle East conflict call for caution. That being said, the levels that the major indices have fallen to could constitute initial entry points once the current uncertainties have been partially lifted.
OUR VIEWS AS OF 07/11/2023
Central banks are moving into pause mode. But monetary tightening is not over yet, as bond yields constitute another form of tightening, and central bank balance sheets yet another. With a T-Note yield at 4.93% at month-end and a Bund yield at 2.80%, we remain bullish on the bond markets. In light of the prevailing uncertainties, we prefer money-market assets, which we have raised further in our allocation grid, in view of new geopolitical risks and what we see as a favourable risk/reward ratio. We reiterate our bullish stance on sovereign yields above the Bund’s 2.60%. Against the current backdrop, we are lowering sovereign debt and investment grade and high yield corporate bonds to the same degree of overweighting while sticking to our preference for the highest-rated segment of high yield, particularly for BB rated issuers.
The global environment became even more challenging in October when the situation degenerated in the Middle East. Risks are accumulating, but the financial markets seem to have adjusted to them. True, the world’s largest economy continues to defy gravity, as seen in the upward revision of third-quarter US growth figures. That being said, quarterly releases are nothing to be excited about, and guidance for coming quarters is becoming marginally more conservative, with reduced visibility on the outlook. Some risks, particularly on future margins, do not appear to be fully priced in by the consensus, and this, in our view, will remain the equity markets’ Achille’s heel in the coming months.
Since July, the dollar had ridden the US economy’s outperformance vs. the euro. This upward trend levelled off in October, before reversing itself in early November on weaker-than-expected US statistics. We don’t see any real short-term catalyst for the euro-dollar exchange rate. The Bank of Japan has loosened its yield-curve control policy, but that was not enough to strengthen the yen. Not since 2008 has the yen been so weak vs. the euro, at above 160. We remain constructive on the yen on a medium-term horizon, under the assumption that normalisation of monetary policy in Japan will continue.
THE WILD, WILD WEST
Head of Macroeconomic Research
OFI INVEST ASSET MANAGEMENT
US growth this year remains surprisingly strong. In the third quarter, GDP expanded by 4.9% on an annualised pace. Even when subtracting the contribution from inventories, the pace of growth would still be above 3.5%, hence higher than in the first half of 2023 and well above its long-term level. It is worth summing up all the factors that, in our view, may explain the US economy’s surprising performance in 2023 and that have postponed the impact of monetary tightening.
- 1/ Bidenomics. First, Covid-related assistance allowed households to fall back on unprecedented excess savings in order to consume (excess savings that, according to the latest revisions of US national accounts, remain very significant). Second, the plans passed in August 2022 to support the energy transition (the Inflation Reduction Act (IRA)) and semiconductors (CHIPS Act) stimulated private investment and research & development spending in unprecedented fashion, as seen in a recent study by the US Treasury(1).
- 2/ Less of a need for US companies to refinance in 2023: they had lots of cash at their disposal and were able to benefited from several years of low rates (and even negative ones in 2020 and 2021) to refinance and extend their debt maturities.
- 3/ A monetary policy that remained accommodative over much of 2022, given the exceptionally low starting level of key rates(2).
A US SLOWDOWN LOOMING IN 2024
For all these reasons, it is reasonable to believe that some of the effects of monetary tightening are still in the pipeline(3). This should produce an economic slowdown sometime in 2024, although these same factors could still soften the impact on activity.
This does not take into account the one-off risks that could come to bear late this year, such as a possible total or partial shutdown of the US federal government owing to Congressional disagreement on the budget.
In contrast to the US, GDP contracted by 0.1% in the euro zone in the third quarter. The very first indicators released for the fourth quarter are for the moment pointing to activity that will at best stagnate. Moreover, the negative impact of monetary tightening will remain a drag on growth in the coming quarters, whereas only a receding in inflation is likely to boost household purchasing power and prop up demand.
The overall trend in risks is on the downside, and the geopolitical risk of an escalation of the war in the Middle East could plunge the euro zone into a sustained stagflationary environment. The impact of the conflict could show up through two main channels: commodity prices, as Europe is more exposed than the US to the Middle East for its energy needs, via natural gas; and confidence, as geopolitical tensions exacerbate the factors of uncertainty, which, in turn, would undermine the confidence of economic actors and promote a wait-and-see attitude by households and businesses.
THE EURO ZONE IS BETTING ON LOWER INFLATION
But there is also some good news in the euro zone! Total inflation slowed to 2.9% in October (from 4.3% in September), thanks mainly to the energy base effect. In addition, uneven emergency measures from one European country to another to keep energy prices in check, and their uneven withdrawal, continue to cause a wide dispersion of total European inflation. The Netherlands and Belgium have even experienced temporary deflation. Beyond these one-off trends, momentum in core inflation (ex energy and food) has continued to decline month after month, to 4.2% after 4.5% in September, and most leading indicators suggest that this downward trend is likely to continue in the coming months.
In the US, the trend is less clear for the coming months, as core inflation has slowed from 4.3% to 4.1%, and masks a reacceleration in services prices that should be watched over. Total inflation was stable in September at 3.7% but is likely to rise temporarily by yearend.
On both sides of the Atlantic, data confirm that the return of inflation towards the target will be a gradual process, justifying the keeping of nominal and real key rates at their current levels. In such an environment, central banks are unlikely to be able to consider easing their monetary policies until at least the second half of 2024.
(2) In deflating key rates by the University of Michigan’s one-year household inflation expectations, we can see that real short-term rates did not move into positive territory until the very end of 2022.
(3) The literature estimates that monetary tightening’s maximum impact on the real economy shows up at an average lag of 12 and 24 months, although the estimates vary widely from one study to another. Moreover, all the aforementioned points may have extended this estimated average timeframe.
AMERICA IS LOOKING GREAT AGAIN
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT
The US economy remained surprisingly strong in October. The 10-year yield rose for the sixth consecutive month. The T-Note even brushed up against 5.00% before ending the month at 4.93%. This did not last very long, as rates pulled back by almost 40 basis points in three small sessions in early November, following the US Federal Reserve meeting. The Fed is in pause mode following Jerome Powell’s speech suggesting that key rates are likely to remain stable for several months. The markets also continue to price in moderate rate cuts for 2024 in both the US and Europe and are increasingly pricing in the rhetoric of high-for-long interest rates.
IS THE LATEST SPIKE IN YIELDS THE LAST ONE?
In 2022, US rates peaked in October at close to 4.25% on the 10-year yield. At the time, this looked like a high that the markets would not see again. But, one year ago, US inflation was still close to 8% and key rates were “only” 3%. In 2023, the same thing happened again, with the 10-year US yield hitting what looks like the peak on the year. We obviously cannot rule out a scenario of an even higher spike, but that looks unlikely for three reasons.
First, US inflation is now at 3.7% and is likely to pull back below 3.0% in 2024. Second, the Fed has raised its key rates to 5.25%/5.50% and is likely to stick to these levels for another several months. Third, and most significantly, strong economic momentum in the US is likely to slow in the short or medium term, due to tighter monetary conditions on the one hand and geopolitical risks on the other. Indeed, the situation in the Middle East is adding strong uncertainty that the fixedincome markets seem to be trying to ignore for the moment. Against this backdrop, we prefer to stick to a long-sensitivity bias and continue to overweight sovereign yields. As for the 10-year German yield, which was still at 2.80% at month-end, this context has made us even more confident in maintaining this long bias above the 2.50%/2.60% zone.
IS THE EUROPEAN CREDIT MARKET STILL WORTH OVERWEIGHTING?
High rates, particularly real rates, are likely to bring back specific risks for both governments and companies.
This is starting to be priced in on equity markets and, to a lesser extent, bond markets. As we said last month, credit is becoming more expensive only gradually and the impact is unlikely to be felt for several more quarters. While this applies to all fixed-income asset classes, some companies are beginning to feel the pinch of monetary tightening before others. Hence, the importance of being selective in choosing investments.
YES FOR THE CARRY TRADE BUT KEEP AN EYE OUT ON SPECIFIC RISKS
We accordingly remain bullish on investment grade and high yield corporate bonds, while overweighting the most solid issuers. Hence, within high yield, for example, our preference will be for BB rated issuers. Within this selectiveness, high yield funds could perform relatively well. Even so, on a horizon of about six months, and in light of macroeconomic risks and current valuations, we are repositioning government bonds and investment grade and high yield corporate bonds at the same level. In the event of even a slight widening of spreads, interest-rate trends are likely to support longduration assets.
For the short term, the money market looks like the most attractive asset class from a risk/reward point of view, with rates close to 4%.
This is the level of the 10-year US yield reached in intraday trading on 23 October 2023.
|BOND INDICES WITH COUPONS REINVESTED||OCTOBER 2023||YTD|
|Bloomberg Barclays Euro Aggregate Corp||0.40%||2.94%|
|Bloomberg Barclays Pan European High Yield in euro||- 0.30%||6.44%|
Past performances are not a reliable indicator of future performances.
INVESTOR NERVOUSNESS HAS NOT ABATED SINCE LAST SUMMER
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT
The worsening of the geopolitical situation is not reason enough to explain the erratic behaviour of the financial markets since the end of summer. The equity markets have fallen almost worldwide, with the MSCI World down by more than 7% in the past two months. Japan alone has fared decently, compared to other markets, thanks to a monetary policy that remains ultraaccommodative.
GEOPOLITICAL TENSIONS HAVE NOT RAISED RISK PREMIUMS
The geopolitical risk worsened further in October, and in the worst possible way. The conflict between Israel and Hamas has exacerbated the risk of an escalation throughout the Middle East, with possible repercussions on oil supplies and prices. We might have expected a surge in risk premiums, alongside a flight to safety. But nothing of the sort has taken place.
Equity market valuations, particularly in the US, remain at highs in comparison with real rates. And fixed-income markets did not at first offer investors a safe haven, as might have been expected. They even rose further, with the 10-year US rate even venturing above 5% for a few hours.
US HOUSEHOLD CONSUMPTION IS HOLDING UP WELL
Clearly, the US economy has been completely oblivious to all this background noise. GDP even surged in the third quarter (by 4.9%!), driven by household consumption, which remains robust, especially in services. But company restocking also appears to have played a significant role in this surge. This has also been corroborated by the earnings reports of several US companies, such as Caterpillar*, AGCO* and others, which have showed that end-demand may be less strong than expected. Moreover, third-quarter releases contained far fewer positive surprises than suggested by the upward revision in economic aggregates. Growth remains negative in volume terms, with price effects accounting for all organic growth on the quarter.
BUT BUSINESS LEADERS ARE MORE CAUTIOUS
Comments from business leaders also a little look more measured.
There are increasing signs of weaker final demand and of a fringe of the US population forced into consumption trade-offs by higher and higher prices and by partially used up excess savings. Accordingly, consensus 2024 earnings forecasts look just as improbable, as they imply that corporate margins will rise further, by more than one percentage point next year, something that we feel is out of reach in the current context.
EUROPE STILL IN THE DOLDRUMS
In Europe, the economy continues to worsen, and some countries, including Germany, are already flirting with recession. Quarterly reporting season has hit its stride and thus far has not pushed consensus forecasts any lower, a sign that analysts have already factored in the ongoing slowdown into their forecasts. However, the equity markets’ performances show that investors are not buying into this. The good surprises barely move the needle, either in Europe or the US. Disappointments, however, have been punished mercilessly with steep drops, sometimes more than 10%. So, risk appetite is still just as low, given an economy that is having a hard time rebounding and a downgraded geopolitical context. In such a context, the 4% payout on cash is a serious competitor to an investment in equities.
This is how much the market punished Worldline* on Wednesday 25 October after its profit-warning. This was the biggest plunge ever by a CAC 40 stock since the index was created.
|EQUITY INDICES WITH NET DIVIDENDS REINVESTED, IN LOCAL CURRENCIES||OCTOBER 2023||YTD|
|CAC 40||- 3.50%||8.70%|
|S&P 500 in dollars||- 2.13%||10.25%|
|MSCI AC World in dollars||- 3.01%||6.75%|
Past performances are not a reliable indicator of future performances.
Past performances are not a reliable indicator of future performances.
ASIA EX-CHINA: THE ADVANTAGES OF A « CHINA+1 » STRATEGY
Chief Executive Officer
SYNCICAP ASSET MANAGEMENT
How should investing in Asian equities be regarded in a context in which the region’s most powerful country, China, is highly controversial and seems to be uncoupling from the rest of the world?
Asia encompasses almost two thirds of humanity and accounts for almost 50% of global GDP. And yet, its financial market weighting is still far from matching its demographic and economic momentum.
China’s rise over almost the past three decades has been spectacular. It has become so prominent that it has “crushed” its neighbours under its economic and financial market weight. But the toughening of international relations and domestic political trends in China are forcing it to look inward. Chinese market dynamics are thus responding increasingly to its own domestic logic. A “pure” Chinese equities strategy accordingly constitutes a separate brick in constructing an international equity portfolio. And, lastly, for political reasons, some investors may wish to avoid China, which is an argument for disassociating it from the rest of Asia.
Now is the time for “two dimensional” thinking in Asian equity investment strategies – China and ex China. In short, a “China +1” strategy.
INVESTMENTS ARE SHIFTING TO THE REST OF ASIA
Against a backdrop of cold war between the US and China, we have been seeing international investments flow to the rest of Asia over the past few months.
The Covid crisis showed that Western countries had become overly dependent on Chinese manufacturing. A process of diversification is taking shape. Several Asian countries are well placed to receive these investments, for political reasons (India, the world’s largest democracy) and also for labour cost competitiveness (Vietnam, Indonesia, and others). China, meanwhile, is turning towards other markets under its Belt and Road Initiative, which has just marked its 10th anniversary in Beijing in October following the BRICS summit meeting. The summit marked a greater engagement of China with these partners that have become strategic, a list to which we could add Saudi Arabia. The BRICS have very many potential areas of cooperation, particularly in the energy sector. China still needs oil in the short term, but could swap it out for its acknowledged capabilities in renewable, solar and green hydrogen energies, which everyone will need in the post-petroleum age.
The EM Asia ex-China equity index is broad-based and represents an asset class that is far from being marginal.
It has almost 425 stocks and total market cap of about $3,160bn (vs. almost $2,230bn for the CAC 40). It is also the fourth-largest weighing of the All Countries international equity index (see table below). Geographically, it includes Asia’s main countries (except China), some of which are at less advanced stages of development, something that offers greater growth potential. The index’s top weightings are India (32.4%), Taiwan (30.0%), and Korea (25.0%). It is also attractive from a sector point of view, with almost 38% made up of cutting-edge information technology industries. The rest of the index is rather well diversified with almost 20% financials, 8% industrials, and about 7% consumer stocks and also 7% materials.
SEEKING OUT ASIA’S MOST CONSENSUAL COUNTRIES
All told, Chinese and ex China Asian equities are complementary strategies. China is now a pure value play that international investors have avoided because of its more challenging governance issues and the deflating of its real-estate bubble. As a result, the 12-month forward P/E of the MSCI China index is now below 10. The rest of Asia is more “consensual” and a “GARP” (growth at a reasonable price) story, which accordingly is priced higher, at a 12-month P/E of 12.5), but which also is being driven by inflows and is complementary as it is both correlated to Chinese and international economic activity.
This is the weighting of Asian EM ex China equities, or the fourth weighting in the All Countries index.
|EM Asia ex-China||5.0%|
Syncicap AM is a portfolio management company owned by Ofi Invest (66%) and Degroof Petercam Asset Management (34%), certified on 4 October 2021 by the Hong Kong Securities and Futures Commission. Syncicap AM specialises in emerging markets and provides a foothold in Asia, from Hong Kong.
Document completed on 07/11/2023
Carry: a strategy that consists in holding bonds in a portfolio, possibly even till maturity, in order to tap into their yields.
Core inflation: inflation ex energy and ex food.
Duration: weighted average life of a bond or bond portfolio expressed in years.
Inflation: loss of purchasing power of money which results in a general and lasting increase in prices.
Investment Grade / High Yield credit: Investment Grade bonds refer to bonds issued by borrowers that have been rated highest by the rating agencies. Their ratings vary from AAA to BBB- under the rating systems applied by Standard & Poor’s and Fitch. Speculative High Yield bonds have lower credit ratings (from BB+ to D, according to Standard & Poor’s and Fitch) than Investment Grade bonds as their issuers are in poorer financial health based on research from the rating agencies. They are therefore regarded as riskier by the rating agencies and, accordingly, offer higher yields.
PER: Price to Earnings Ratio. A stock market analysis indicator: market capitalisation divided by net income.
Spread: difference between interest rates. Credit spread is the difference in interest rate between a corporate bond and a same-dated benchmark bond that is regarded as the least risky (benchmark government bond). Sovereign spread is the difference in interest rate between a sovereign bond and a same-dated benchmark bond that is regarded as the least risky (German benchmark government bond).
Volatility: corresponds to the calculation of the amplitudes of variations in the price of a financial asset. The higher the volatility, the riskier the investment will be considered.
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